Course Description

This course offers theoretical and intuitive coverage of investments, with an emphasis on portfolio theory. It includes extensive discussions on capital asset pricing, arbitrage pricing, pricing of derivative securities, interest rates, and bond management. Stock valuation, estimating future earnings and dividends, and fixed income markets are examined closely. Theoretical development and practical applications, at the level of the individual investor, are emphasized.

This course is intended for undergraduate seniors seeking an upper level course in investment management. It is also appropriate for graduate students seeking a Finance concentration. In general, it requires a background in calculus and statistics as well as prior completion of a basic investments course.

Course Prerequisites

MGMT 443 (for undergraduates); MGMT 611 (for graduates)

Course Objectives

This course will provide insight into the theory of investment management. The theory provides the tools to manage investment risk, evaluate securities for their intrinsic values, and measure the performance of investment portfolios. Among other objectives, you will understand:

· How securities are priced

· How the value of securities are impacted by risk

· How securities may considered for inclusion into an investment portfolio

· The forces that influence the direction of both short term and long term interest rates

· How to measure the risk of an investment

· The structure and pricing of futures and options

· Evidence on market efficiency

Learning Objectives

At the end of the course, you should be able to:

1. Describe an efficient capital market

2. Explain the nature of financial assets and derivatives trading on major exchanges

3. Solve risk/return problems for individual assets and portfolios

4. Distinguish between single factor and multifactor estimation models

5. Define the concepts of “utility” and “risk aversion”

6. Identify the characteristics of an optimal portfolio

7. Show how the “efficient set” is constructed and explain its implication to a risk-averse investor

8. Solve security valuation problems using CAPM and APT models

9. Evaluate asset performance using risk-adjusted performance measures

10. Explain the concept of “interest immunization” as it applies to bond portfolio management

11. Solve transactional problems in options and futures contracts, and show how these contracts may be used to hedge bond and stock portfolios

Course Text

1. Modern Portfolio Theory, 5^th edition. By Haugen. Prentice Hall, 2001

2. Financial calculator: BA II PLUS is recommended

Grades and Policies

Exam 1 30%

Exam 2 30%

Quizzes 20%

Project 20%

A ³ 90%; B ³ 80%; C ³ 70%; D ³ 60%; F £ 59%.

Project

You will complete a term project dealing with either security analysis or portfolio management. The specifics of the project will be given later in the semester. Global events that will be covered in the project include

1. Introduction of the euro (in 1/1/1999)

2. Asian contagion (Southeast Asian financial crises in 1997)

3. Latin American Financial crises (Mexico: December 1995; Brazil: January 1999; Argentina: December 2001)

4. 9-11 Terror attacks in America

5. Enron debacle of January 2002

Financial variables that will be analyzed with respect to above events include

1. Exchange rates (with respect to euro, sterling, yen, real, and peso)

2. Stock market indexes (US, UK, Germany, Japan, South Africa, Brazil, Argentina)

3. Option prices (call and put prices of specified stocks or stock indexes)

Attendance and Participation

Attendance is mandatory. A penalty of 2% will be deducted from your final score for each class you miss after your second absence.

Exams

· Complaints will not be considered 24 hours after graded papers are returned to you.

· You must notify the instructor no less than 48 hours if you cannot take a scheduled exam

· A make-up test will only be given (within 72 hours of scheduled test) upon the presentation of a written verification from a physician or employer regarding your inability to take the exam.

Other Matters

· You are welcome to maintain a formula sheet for use during in-class quizzes and exams

· Please keep a copy of all graded work in order to verify your final scores

· Late submission of assigned work without instructor approval will not be accepted

· Uncollected graded assignment can be picked up at a later time from the office

· It is your responsibility to make arrangements to obtain any handouts given in your absence

· Homework assignment will be inspected for credit

· Visit the class website daily for schedule updates and new information

A Note on Academic Honesty

Honesty and integrity in academic and personal pursuits are hallmarks of higher education. By acting honestly and with integrity, students maintain and uphold their own reputations, and the reputation of both the School of Management and the University. The Students Handbook states that “the commitment of the acts of cheating, lying, stealing and deceit in any of their diverse forms (such as the use of ghost-written papers, use of substitutes for taking examinations, the use of illegal cribs, plagiarism, and copying during exams) is dishonest.” Also, aiding and abetting in committing dishonest acts is in itself dishonest. The penalty for any student(s) involved in any of such acts will range from an outright zero in the specific assignment the act was committed to a grade of “F” in the course.

Students with Disabilities

In compliance with the Americans with Disabilities Act (ADA), all qualifying students enrolled in this course are entitled to reasonable accommodations. It is the student’s responsibility to inform the instructor of any special needs before the end of the second week of classes.

Term Project (Mgmt 516)

Project Titles

1. A Study of Market Overreaction

· Hypotheses regarding responses to abnormal price movements:

i. Overreaction hypothesis: Extreme one-day movements in stock prices will be followed by significant movements in the opposite direction. Contrarian argument.

ii. Under-reaction hypothesis: Extreme one-day movements in stock prices will be followed by significant movements in the same direction. Relative strength theory.

iii. Efficient markets hypothesis: Extreme one-day movements in stock prices will not be followed by significant movements in stock prices

· Define variables whose overreactions and under-reactions are to be studied: stock indexes, individual stocks, exchange rates, and crude oil futures

· Define event: 9-11 or introduction of the euro

· Define event day: 9/11/01 (for 9-11) or 1/1/99 (for euro)

· Define pre-event period: 9/4/01 – 9/10/01

· Define post-event period: 9/18/01 – 11/30/01 {first trading day after 9-11 is 9/17/01}

· Define parameter estimation period: January 1996 – May 2001

· Calculate abnormal returns (AR) for each variable using the mean adjusted return (AR) model as follows:

AR_jt = R_jt -

· Regress AR for each foreign stock index (FSI) on S&P 500 (SP), oil futures (OF), exchange rate for euro (X), dummy variable for 9-11 (D1) and dummy variable for introduction of the euro (D2), as follows:

FSI = B₀ + B₁SP + B₂OF + B₃X + B₄D1 + B₅D2 + u

2. A Cross-sectional Study of Market Overreaction

· Obtain sample of stocks believed to be influenced by either intro. of the euro or 9-11

a. Airline stocks

b. Petroleum stocks

c. Financial services stocks

· Compute abnormal returns (AR) for each stock using the mean adjusted abnormal returns (AR) model as follows:

AR_jt = R_jt -

· Compute Sharpe Performance Index (SPI) for each stock over the event period:

SPI_jt =

· Do a cross-sectional regression of each stock’s abnormal return (ARj) on

a. Leak variable (3-day pre-event cumulative abnormal return)

b. SPI

ARjt = B₀ + B₁LEAK + B₂SPI + u

Data Description

Data set A: Crude oil

Spot crude oil price
I-month crude oil futures price

Data set B: Stocks

Airline stocks
Petroleum stocks
Financial services stocks

Data set C: Exchange rate

Euro
Yen
Sterling
Real
Rand
Mexican peso

Data set D: Stock indices

S&P 500
UK
Germany
South Africa
Brazil
Singapore
Japan

Reference Paper

Larson, S.J., Jeff Madura, and Aigbe Akhigbe (2001). “Foreign Equity and Market Overreaction,” Global Business and Finance Review, spring, pp. 1-11.

Reference paper abstract

Larson, Madura, and Akhigbe (GBFR 2001) examine abnormal returns of American depository receipts (ADRs) after extreme share price movements. They find that investors under reacted to bad news so that for loser stocks, their abnormal returns even after the bad event had occurred continued to be negative. For winner stocks, their abnormal returns after the day of good news became negative. They then concluded that it appears that investors overreacted to favorable news and in a bid to correct themselves, reprised these stocks into producing negative abnormal returns (AR). Abnormal returns are based on the following risk-adjusted market model:

AR_t = r_t – ( ,

where

AR_t = Abnormal return on day t,

r_M = Market return, and the model parameters are a and b.